PARIS/BERLIN France and Germany are close to agreeing to a shake-up of EADS, Europe's largest aerospace group, by hiving off part of the French government's stake to make way for Berlin as a shareholder, sources familiar with the matter said.

The deal is expected to be completed before the end of the year and would see a rise of state shareholdings in the Airbus parent to make way for German demands for parity with France -- offset by far fewer special rights than France currently enjoys.

It would also mark the end of a shareholder pact between government and industrial shareholders that has been criticized for lacking transparency and pave the way for an exit by media firm Lagardere (LAGA.PA) and German carmaker Daimler (DAIGn.DE).

EADS EAD.PA shares rose more than 2 percent and were the highest gainer in the French CAC40 .FCHI blue-chip index on Friday.

"Overall, it is a reasonably helpful development, but it is hard to see these direct government stakes as benign shareholdings," said Agency Partners analyst Nick Cunningham.

"It still implies a propensity to interfere, but has potential to resolve the issue."

EADS' structure has been an urgent political issue since last month's failure of $45 billion merger talks with UK arms firm BAE Systems (BAES.L) exposed the fragility of existing arrangements and re-energized German efforts to enter the group.

German Chancellor Angela Merkel blocked the BAE deal and talks began immediately to bring her government in and let the industrial partners out, eager to focus on core activities.

A stumbling block has been the difficulty of fitting French, German and Spanish state shareholdings under a combined 30 percent ceiling in the Netherlands, where EADS is registered.

Breaching this ceiling would force the nations, hit by the financial crisis, to mount a stunning 21 billion euro bid for the whole of EADS, amounting to its accidental nationalization.

Spain owns 5.5 percent, so to avoid this the maximum France and Germany can own while respecting Berlin's desire for parity is 12 percent each. France owns 15 percent, so it has a surplus of three percent that negotiators must find a home for.

The website of French newspaper Le Figaro dismissed earlier suggestions that France could sell three percent of EADS to Germany to help Berlin build its stake, saying France's Socialist government remained unwilling to reduce its stake.

Instead, sources familiar with the matter told Reuters that France could renounce voting rights for one fifth of its 15 percent stake by placing it in a special non-voting structure.

This would allow France and Germany to hold 12 percent each inside a newly formed, government-only core shareholding group.

France would maintain economic ownership of the remaining three percent but would not exercise the attached votes.

A similar arrangement was made for a handful of shares left outside the shareholder pact when EADS was first created.

"It is a very plausible option," a person familiar with the discussions said.

The sources, who asked not to be identified, said the politically sensitive deal affecting strategic assets like French rockets and German fighters had not yet been completed.

EADS officials declined to comment.

OVERHANG REDUCED

The possible decision by the French state to keep all its shares is significant for investors since it automatically reduces the potential overhang of Daimler stock that must be sold quickly to keep national shareholdings in balance.

Germany plans to build its 12 percent by buying from a consortium led by Daimler, which owns 7.5 percent, topped up from within a second 7.5-percent tranche held by Daimler itself.

This implies that Daimler would sell the leftover 3 percent to keep the two sides even. Had France sold three percent to Germany, Daimler's immediate surplus would have been 6 percent.

After such an operation, Daimler would still be left with a third tranche of 7.5 percent, balanced by Lagardere's 7.5 percent. Lagardere has said it wants to sell next year. Daimler has not said when it wants to complete its exit from EADS.

In the past, the companies have used bonds or forward sales to limit the damage to the share price of selling such large packets of shares. The Wall Street Journal reported that EADS could weigh a share buyback to smooth out the price impact.

Pending a complete pull-out, Dutch legal experts say any remaining Daimler and Lagardere shares would be treated as part of the market's free float, meaning the firms would need to formally abandon their allegiance to former government partners.

By dismantling the shareholder pact, EADS nations have automatically committed because of the way Dutch law operates to raising the free float to 70 percent from below 50 percent.

(Additional reporting by Cyril Altmeyer and Gernot Heller; Editing by Mark John and Leslie Gevirtz)

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